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Behavioral Investing

Publisher John Wiley & Sons has done it again with its Little Book Big Profits series and come up with a gem in James Montier's The Little Book of Behavioral Investing. Anchoring, confirmatory bias, over-optimism, illusion of control, self-serving bias, hindsight bias, myopia and many other behavioral finance topics are covered in this excellent read for not only the novice, but the experienced investor as well. Most of the books in this series come from the vantage of the value investor and Montier's is no exception to the rule. In fact, besides being a value investor, Montier is a contrarian with not necessarily a disdain, but an aversion to economists, analysts and institutional investors. Montier quotes well known value investors and behavioral economists throughout The Little Book of Behavioral Investing and builds a strong case for being an independent investor, one not following the herd for out sized profits. Here is a quote from Robert Shiller demonstrating why there is so much of a lemming mentality on Wall Street: "Deviating too far from consensus leaves one feeling potentially ostracized from the group, with the risk that one may be terminated.".

Overconfidence is a topic that surfaces again and again throughout the book with the professionals getting the brunt of Montier's rancor: "When I asked a sample of more than 600 professional fund managers how many of them were above average at their jobs, an impressive 74 percent responded in the affirmative...Similarly, some 70 percent of analysts think they are better than their peers at forecasting earnings - yet, the very same analysts had 91 percent of their recommendations as either buys or holds in February 2008.". To sum it up best: "Perhaps the most striking example of overconfidence among professionals is their general belief that they can outsmart everyone else - effectively, get in before everyone else and get out before the herd dashes for the exits.". As a value investor Montier believes you should get out of the market when valuations become too rich and not follow the momentum crowd: "...when the bottom-up search for opportunities fails, investors would be well advised to hold cash. As the Sage of Omaha has said 'Holding cash is uncomfortable, but not as uncomfortable as doing something stupid.'".

The Little Book of Behavioral Investing continuously takes pot shots at the powers that be in economics and finance and spares no one: "We'll start at the top with the economists. These guys haven't got a clue. Frankly, the three blind mice have more credibility at seeing what is coming than any macro-forecaster. For instance, the consensus of economists has completely failed to predict any of the last four recessions (even once we were in them)...When an analyst first makes a forecast for a company's earnings two years prior to the actual event, they are on average wrong by a staggering 94 percent. Even at a 12 month time horizon, they are wrong by about 45 percent!". So what is an investor to do if you can't believe the professionals? Montier believes you should follow the teachings of Benjamin Graham and value companies for their intrinsic worth.

I admired Montier's moxie for taking numerous jabs at the financial "establishment" and he has every right to do so being a strategist himself with impressive credentials. I have read other behavioral finance books and still, I got a lot out of this book because it is written from the perspective of the value investor. Like Montier states: "...the curse of the value investor is to be too early - both in terms of buying (known affectionately as premature accumulation) and in terms of selling. Unfortunately, in the short term being early is indistinguishable from being wrong.". So far in the Ithaca Experiment portfolio I have been wrong because I was early to the game. I have patience though and will ride out the storm.